While RBI is holding rates steady, government needs to overhaul food markets.

Although the RBI didn’t announce a rate cut at its second bi-monthly policy review yesterday, its tone was dovish. Whether it will cut interest rates sometime this fiscal in order to crank up the economy depends on how overall inflation, particularly food inflation, behaves.

India’s GDP growth was below 5 per cent in the eight quarters leading up to March 2014, but consumer price index (CPI) inflation has been sticky at around twice that (10 per cent). Clearly, inflation is not the byproduct of excessive demand or growth alone. To be sure, we are not in stagflation territory because the economy continues to grow. But high inflation in a slowing economy does generate stagflation-like concerns and makes the RBI’s task that much more difficult.

While GDP growth remained below 5 per cent in the fourth quarter of 2013-14, retail inflation offered some respite as it declined to 8 per cent in February. And after a long time, wholesale price index (WPI) inflation too was under 5 per cent.

Taking the cue, the RBI pushed the pause button on rate hikes in April.

But, at least for now, the weakness in domestic demand persists. Industrial production data disappointed yet again, declining 0.5 per cent in March. The respite from price rise too may be transient — CPI inflation spiked again to 8.3 per cent in March and 8.6 per cent in April. This resurgence was led by inflation in vegetables, fruit, milk and milk products.
The threat of a poor monsoon due to the increasing odds of El Nino further complicates matters for the RBI. The Indian Meteorological Department now estimates there is a 60 per cent chance of the phenomenon playing out this year, thereby raising the probability of a deficient monsoon.

If the rains indeed turn out to be below normal, we will be back to square one — growth will retreat as inflation accelerates. This is the last thing we need when manufacturing is barely growing and service sector growth is decelerating. In the event, India’s growth would be around 5.2 per cent this fiscal rather than Crisil’s predicted 6 per cent, and the RBI will be forced to become hawkish.

Unreliable monsoons are a risk we have to manage and mitigate on an ongoing basis. But the bigger question is: is entrenched and elevated food inflation the new normal? That food inflation spikes even when monsoons are normal supports this thesis. Researchers at Crisil have found that the drivers of food inflation seem random: vegetables and fruit in 2012-13, oils and fats in 2011-12, condiments and spices in 2010-11, pulses in 2009-10, cereals and pulses in 2008-09, and oils and fats continued…